by Adam Hartung | Feb 11, 2016 | Current Affairs, In the Whirlpool, Leadership, Lock-in
USAToday alerted investors that when Sears Holdings reports results 2/25/16 they will be horrible. Revenues down another 8.7% vs. last year. Same store sales down 7.1%. To deal with ongoing losses the company plans to close another 50 stores, and sell another $300million of assets. For most investors, employees and suppliers this report could easily be confused with many others the last few years, as the story is always the same. Back in January, 2014 CNBC headlined “Tracking the Slow Death of an Icon” as it listed all the things that went wrong for Sears in 2013 – and they have not changed two years later. The brand is now so tarnished that Sears Holdings is writing down the value of the Sears name by another $200million – reducing intangible value from the $4B at origination in 2004 to under $2B.
This has been quite the fall for Sears. When Chairman Ed Lampert fashioned the deal that had formerly bankrupt Kmart buying Sears in November, 2004 the company was valued at $11billion and 3,500 stores. Today the company is valued at $1.6billion (a decline of over 85%) and according to Reuters has just under 1,700 stores (a decline of 51%.) According to Bloomberg almost no analysts cover SHLD these days, but one who does (Greg Melich at Evercore ISI) says the company is no longer a viable business, and expects bankruptcy. Long-term Sears investors have suffered a horrible loss.
When I started business school in 1980 finance Professor Bill Fruhan introduced me to a concept that had never before occurred to me. Value Destruction. Through case analysis the good professor taught us that leadership could make decisions that increased company valuation. Or, they could make decisions that destroyed shareholder value. As obvious as this seems, at the time I could not imagine CEOs and their teams destroying shareholder value. It seemed anathema to the entire concept of business education. Yet, he quickly made it clear how easily misguided leaders could create really bad outcomes that seriously damaged investors.
As a case study in bad leadership, Sears under Chairman Lampert offers great lessons in Value Destruction that would serve Professor Fruhan’s teachings well:
1 – Micro-management in lieu of strategy. Mr. Lampert has been merciless in his tenacity to manage every detail at Sears. Daily morning phone calls with staff, and ridiculously tight controls that eliminate decision making by anyone other than the top officers. Additionally, every decision by the officers was questioned again and again. Explanations took precedent over action as micro-management ate up management’s time, rather than trying to run a successful company. While store employees and low- to mid-level managers could see competition – both traditional and on-line – eating away at Sears customers and core sales, they were helpless to do anything about it. Instead they were forced to follow orders given by people completely out of touch with retail trends and customer needs. Whatever chance Sears and Kmart had to grow the chain against intense competition it was lost by the Chairman’s need to micro-manage.
2 – Manage-by-the-numbers rather than trends. Mr. Lampert was a finance expert and former analyst turned hedge fund manager and investor. He truly believed that if he had enough numbers, and he studied them long enough, company success would ensue. Unfortunately, trends often are not reflected in “the numbers” until it is far, far too late to react. The trend to stores that were cleaner, and more hip with classier goods goes back before Lampert’s era, but he completely missed the trend that drove up sales at Target, H&M and even Kohl’s because he could not see that trend reflected in category sales or cost ratios. Merchandising – from buying to store layout and shelf positioning – are skills that go beyond numerical analysis but are critical to retail success. Additionally, the trend to on-line shopping goes back 20 years, but the direct impact on store sales was not obvious until customers had long ago converted. By focusing on numbers, rather than trends, Sears was constantly reacting rather than being proactive, and thus constantly retreating, cutting stores and cutting product lines.
3 – Seeking confirmation rather than disagreement. Mr. Lampert had no time for staff who did not see things his way. Mr. Lampert wanted his management team to agree with him – to confirm his Beliefs, Interpretations, Assumptions and Strategies — to believe his BIAS. By seeking managers who would confirm his views, and execute, rather than disagree Mr. Lampert had no one offering alternative data, interpretations, strategies or tactics. And, as Mr. Lampert’s plans kept faltering it led to a revolving door of managers. Leaders came and went in a year or two, blamed for failures that originated at the Chairman’s doorstep. By forcing agreement, rather than disagreement and dialogue, Sears lacked options or alternatives, and the company had no chance of turning around.
4 – Holding assets too long. In 2004 Sears had a LOT of assets. Many that could likely be redeployed at a gain for shareholders. Sears had many owned and leased store locations that were highly valuable with real estate prices climbing from then through 2008. But Mr. Lampert did not spin out that real estate in a REIT, capturing the value for SHLD shareholders while the timing was good. Instead he held those assets as real estate in general plummeted, and as retail real estate fell even further as more revenue shifted to e-commerce. By the time he was ready to sell his REIT much of the value was depleted.
Additionally, Sears had great brands in 2004. DieHard batteries, Craftsman tools, Kenmore appliances and Lands End apparel were just 4 household brands that still had high customer appeal and tremendous value. Mr. Lampert could have sold those brands to another retailer (such as selling DieHard to WalMart, for example) as their house brands, capturing that value. Or he could have mass marketd the brand beyond the Sears store to increase sales and value. Or he could have taken one or more brands on-line as a product leader and “category killer” for ecommerce customers. But he did not act on those options, and as Sears and Kmart stores faded, so did these brands – which largely no longer have any value. Had he sold when value was high there were profits to be made for investors.
5 – Hubris – unfailingly believing in oneself regardless the outcomes. In May, 2012 I wrote that Mr. Lampert was the 2nd worst CEO in America and should fire himself. This was not a comment made in jest. His initial plans had all panned out very badly, and he had no strategy for a turnaround. All results, from all programs implemented during his reign as Chairman had ended badly. Yet, despite these terrible numbers Mr. Lampert refused to recognize he was the wrong person in the wrong job. While it wasn’t clear if anyone could turn around the problems at Sears at such a late date, it was clear Mr. Lampert was not the person to do it. If Mr. Lampert had been as self-analytical as he was critical of others he would have long before replaced himself as the leader at Sears. But hubris would not allow him to do this, he remained blind to his own failings and the terrible outcome of a failed company was pretty much sealed.
From $11B valuation and a $92/share stock price at time of merging KMart and Sears, to a $1.6B valuation and a $15/share stock price. A loss of $9.4B (that’s BILLION DOLLARS). That is amazing value destruction. In a world where employees are fired every day for making mistakes that cost $1,000, $100 or even $10 it is a staggering loss created by Mr. Lampert. At the very least we should learn from his mistakes in order to educate better, value creating leaders.
by Adam Hartung | Oct 16, 2015 | Current Affairs, Defend & Extend, In the Swamp, Lifecycle
Wal-Mart market value took a huge drop on Wednesday. In fact, the worst valuation decline in its history. That decline continued on Thursday. Since the beginning of 2015 Wal-Mart has lost 1/3 of its value. That is an enormous ouch.
But, if you were surprised, you should not have been. The telltale signs that this was going to happen have been there for years. Like most stock market moves, this one just happened really fast. The “herd behavior” of investors means that most people don’t move until some event happens, and then everyone moves at once carrying out the implications of a sea change in thinking about a company’s future.
All the way back in October, 2010 I wrote about “The Wal-Mart Disease.” This is the disease of constantly focusing on improving your “core” business, while market shifts around you increasingly make that “core” less relevant, and less valuable. In the case of Wal-Mart I pointed out that an absolute maniacal focus on retail stores and low-cost operations, in an effort to be the low price retailer, was being made obsolete by on-line retailers who had costs that are a fraction of Wal-Mart’s expensive real estate and armies of employees.
At that time WMT was about $54/share. I recommended nobody own the stock.
In May, 2011 I reiterated this problem at Wal-Mart in a column that paralleled the retailer with software giant Microsoft, and pointed out that because of financial machinations not all earnings are equal. I continued to say that this disease would cripple Wal-Mart. Six months had passed, and the stock was about $55.
By February, 2012 I pointed out that the big reorganization at Wal-Mart was akin to re-arranging deck chairs on a sinking ship and said nobody should own the stock. It was up, however, trading at $61.
At the end of April, 2012 the Wal-Mart Mexican bribery scandal made the press, and I warned investors that this was a telltale sign of a company scrambling to make its numbers – and pushing the ethical (if not legal) envelope in trying to defend and extend its worn out success formula. The stock was $59.
Then in July, 2014 a lawsuit was filed after an overworked Wal-Mart truck driver ran into a car killing James McNair and seriously injuring comedian Tracy Morgan. Again, I pointed out that this was a telltale sign of an organization stretching to try and make money out of a business model that was losing its ability to sustain profits. Market shifts were making it ever harder to keep up with emerging on-line competitors, and accidents like this were visible cracks in the business model. But the stock was now $77. Most investors focused on short-term numbers rather than the telltale signs of distress.
In January, 2015 I pointed out that retail sales were actually down 1% for December, 2014. But Amazon.com had grown considerably. The telltale indication of a rotting traditional retail brick-and-mortar approach was showing itself clearly. Wal-Mart was hitting all time highs of around $87, but I reiterated my recommendation that investors escape the stock.
By July, 2015 we learned that the market cap of Amazon now exceeded that of Wal-Mart. Traditional retail struggles were apparent on several fronts, while on-line growth remained strong. Bigger was not better in the case of Wal-Mart vs. Amazon, because bigger blinded Wal-Mart to the absolute necessity for changing its business model. The stock had fallen back to $72.
Now Wal-Mart is back to $60/share. Where it was in January, 2012 and only 10% higher than when I first said to avoid the stock in 2010. Five years up, then down the roller coaster.
From October of 2010 through January, 2015 I looked dead wrong on Wal-Mart. And the folks who commented on my columns here at this journal and on my web site, or emailed me, were profuse in pointing out that my warnings seemed misguided. Wal-Mart was huge, it was strong and it would dominate was the feedback.
But I kept reiterating the point that long-term investors must look beyond short-term reported sales and earnings. Those numbers are subject to considerable manipulation by management. Further, short-term operating actions, like shorter hours, lower pay, reduced benefits, layoffs and gouging suppliers can all prop up short-term financials at the expense of recognizing the devaluation of the company’s long-term strategy.
Investors buy and hold. They hold until they see telltale signs of a company not adjusting to market shifts. Short-term traders will say you could have bought in 2010, or 2012, and held into 2014, and then jumped out and made a profit. But, who really can do that with forethought? Market timing is a fools game. The herd will always stay too long, then run out too late. Timers get trampled in the stampede more often than book gains.
In this week’s announcement Wal-Mart executives provided more telltale signs of their problems, and the fact that they don’t know how to fix them, and therefore won’t.
- Wal-Mart is going to spend $20B to buy back stock in order to prop up the price. This is the most obvious sign of a company that doesn’t know how to keep up its valuation by growing profits.
- Wal-Mart will spend $11B on sprucing up and opening stores. Really. The demand for retail space has been declining at 4-6%/year for a decade, and retail business growth is all on-line, yet Wal-Mart is still massively investing in its old “core” business.
- Wal-Mart will spend $1.1B on e-commerce. That is the proverbial “drop in the competitors bucket.” Amazon.com alone spent $8.9B in 2014 growing its on-line business.
- Wal-Mart admits profits will decline in the next year. It is planning for a growth stall. Yet, we know that statistically only 7% of companies that have a growth stall ever go on to maintain a consistent growth rate of a mere 2%. In other words, Wal-Mart is projecting the classic “hockey stick” forecast. And investors are to believe it?
The telltale signs of an obsolete business model have been present at Wal-Mart for years, and continue.
In 2003 Sears Holdings was $25/share. In 2004 Sears bought K-Mart, and the stock was $40. I said don’t go near it, as all the signs were bad and the merger was ill-conceived. Despite revenue declines, consistent losses, a revolving door at the executive offices and no sign of any plan to transform the battered, outdated retail giant against growing on-line competition investors believed in CEO Ed Lampert and bid the stock up to $77 in early 2011. (I consistently pointed out the telltale signs of trouble and recommended selling the stock.)
By the end of 2012 it was clear Sears was irrelevant to holiday shoppers, and the stock was trading again at $40. Now, SHLD is $25 – where it was 12 years ago when Mr. Lampert started his machinations. Again, only a market timer could have made money in this company. For long-term investors, the signs were all there that this was not a place to put your money if you want to have capital growth for retirement.
There will be plenty who will call Wal-Mart a “value” stock and recommend investors “buy on weakness.” But Wal-Mart is no value. It is becoming obsolete, irrelevant – increasingly looking like Sears. The likelihood of Wal-Mart falling to $20 (where it was at the beginning of 1998 before it made an 18 month run to $50 more than doubling its value) is far higher than ever trading anywhere near its 2015 highs.
by Adam Hartung | Jul 25, 2015 | Current Affairs, In the Whirlpool, Leadership
This week an important event happened on Wall Street. The value of Amazon (~$248B) exceeded the value of Walmart (~$233B.) Given that Walmart is world’s largest retailer, it is pretty amazing that a company launched as an on-line book seller by a former banker only 21 years ago could now exceed what has long been retailing’s juggernaut.
WalMart redefined retail. Prior to Sam Walton’s dynasty retailing was an industry of department stores and independent retailers. Retailing was a lot of small operators, primarily highly regional. Most retailers specialized, and shoppers would visit several stores to obtain things they needed.
But WalMart changed that. Sam Walton had a vision of consolidating products into larger stores, and opening these larger stores in every town across America. He set out to create scale advantages in purchasing everything from goods for resale to materials for store construction. And with those advantages he offered customers lower prices, to lure them away from the small retailers they formerly visited.
And customers were lured. Today there are very few independent retailers. WalMart has ~$488B in annual revenues. That is more than 4 times the size of #2 in USA CostCo, or #1 in France (#3 in world) Carrefour, or #1 in Germany (#4 in world) Schwarz, or #1 in U.K. (#5 in world) Tesco. Walmart directly employes ~.5% of the entire USA population (about 1 in every 200 people work for Walmart.) And it is a given that nobody living in America is unaware of Walmart, and very, very few have never shopped there.
But, Walmart has stopped growing. Since 2011, its revenues have grown unevenly, and on average less than 4%/year. Worse, it’s profits have grown only 1%/year. Walmart generates ~$220,000 revenue/employee, while Costco achieves ~$595,000. Thus its need to keep wages and benefits low, and chronically hammer on suppliers for lower prices as it strives to improve margins.
And worse, the market is shifting away from WalMart’s huge, plentiful stores toward on-line shopping. And this could have devastating consequences for WalMart, due to what economists call “marginal economics.”
As a retailer, Walmart spends 75 cents out of every $1 revenue on the stuff it sells (cost of goods sold.) That leaves it a gross margin of 25 cents – or 25%. But, all those stores, distribution centers and trucks create a huge fixed cost, representing 20% of revenue. Thus, the net profit margin before taxes is a mere 5% (Walmart today makes about 5 cents on every $1 revenue.)
But, as sales go from brick-and-mortar to on-line, this threatens that revenue base. At Sears, for example, revenues per store have been declining for over 4 years. Suppose that starts to happen at Walmart; a slow decline in revenues. If revenues drop by 10% then every $100 of revenue shrinks to $90. And the gross margin (25%) declines to $22.50. But those pesky store costs remain stubbornly fixed at $20. Now profits to $2.50 – a 50% decline from what they were before.
A relatively small decline in revenue (10%) has a 5x impact on the bottom line (50% decline.) The “marginal revenue”, is that last 10%. What the company achieves “on the margin.” It has enormous impact on profits. And now you know why retailers are open 7 days a week, and 18 to 24 hours per day. They all desperately want those last few “marginal revenues” because they are what makes – or breaks – their profitability.
All those scale advantages Sam Walton created go into reverse if revenues decline. Now the big centralized purchasing, the huge distribution centers, and all those big stores suddenly become a cost Walmart cannot avoid. Without growing revenues, Walmart, like has happened at Sears, could go into a terrible profit tailspin.
And that is what Amazon is trying to do. Amazon is changing the way Americans shop. From stores to on-line. And the key to understanding why this is deadly to Walmart and other big traditional retailers is understanding that all Amazon (and its brethren on line) need to do is chip away at a few percentage points of the market. They don’t have to obtain half of retail. By stealing just 5-10% they put many retailers, they ones who are weak, right out of business. Like Radio Shack and Circuit City. And they suck the profits out of others like Sears and Best Buy. And they pose a serious threat to WalMart.
And Amazon is succeeding. It has grown at almost 30%/year since 2010. That growth has not been due to market growth, it has been created by stealing sales from traditional retailers. And Amazon achieves $621,000 revenue per employee, while having a far less fixed cost footprint.
What the marketplace looks for is that point at which the shift to on-line is dramatic enough, when on-line retailers have enough share, that suddenly the fixed cost heavy traditional retail business model is no longer supportable. When brick-and-mortar retailers lose just enough share that their profits start the big slide backward toward losses. Simultaneously, the profits of on-line retailers will start to gain significant upward momentum.
And this week, the marketplace started saying that time could be quite near. Amazon had a small profit, surprising many analysts. It’s revenues are now almost as big as Costco, Tesco – and bigger than Target and Home Depot. If it’s pace of growth continues, then the value which was once captured in Walmart stock will shift, along with the marketplace, to Amazon.
In May, 2010 Apple’s value eclipsed Microsoft. Five years later, Apple is now worth double Microsoft – even though its earnings multiple (stock Price/Earnings) is only half (AAPL P/E = 14.4, MSFT = 31.) And Apple’s revenues are double Microsoft’s. And Apple’s revenues/employee are $2.4million, 3 times Microsoft’s $731k.
While Microsoft has about doubled in value since the valuation pinnacle transferred to Apple, investors would have done better holding Apple stock as it has more than tripled. And, again, if the multiple equalizes between the companies (Apple’s goes up, or Microsoft’s goes down,) Apple investors will be 6 times better off than Microsoft’s.
Market shifts are a bit like earthquakes. Lots of pressure builds up over a long time. There are small tremors, but for the most part nobody notices much change. The land may actually have risen or fallen a few feet, but it is not noticeable due to small changes over a long time. But then, things pop. And the world quickly changes.
This week investors started telling us that the time for big change could be happening very soon in retail. And if it does, Walmart’s size will be more of a disadvantage than benefit.
by Adam Hartung | Jul 17, 2015 | Current Affairs, General, In the Swamp, Leadership, Lifecycle
Most analysts, and especially “chartists,” put a lot of emphasis on earnings per share (EPS) and stock price movements when determining whether to buy a stock. Unfortunately, these are not good predictors of company performance, and investors should beware.
Most analysts are focused on short-term, meaning quarter-to-quarter, performance. Their idea of long-term is looking back 1 year, comparing this quarter to same quarter last year. As a result, they fixate on how EPS has done, and will talk about whether improvements in EPS will cause the “multiple” (meaning stock price divided by EPS) will “expand.” They forecast stock price based upon future EPS times the industry multiple. If EPS is growing, they expect the stock to trade at the industry multple, or possibly somewhat better. Grow EPS, hope to grow the multiple, and project a higher valuation.
Analysts will also discuss the “momentum” (meaning direction and volume) of a stock. They look at charts, usually less than one year, and if price is going up they will say the momentum is good for a higher price. They determine the “strength of momentum” by looking at trading volume. Movements up or down on high volume are considered more meaningful than on low volume.
But, unfortunately, these indicators are purely short-term, and are easily manipulated so that they do not reflect the actual performance of the company.
At any given time, a CEO can decide to sell assets and use that cash to buy shares. For example, McDonald’s sold Chipotle and Boston Market. Then leadership took a big chunk of that money and repurchased company shares. That meant McDonalds took its two fastest growing, and highest value, assets and sold them for short-term cash. They traded growth for cash. Then leadership spent that cash to buy shares, rather than invest in in another growth vehicle.
This is where short-term manipulation happens. Say a company is earning $1,000 and has 1,000 shares outstanding, so its EPS is $1. The industry multiple is 10, so the share price is $10. The company sells assets for $1,000 (for purposes of this exercise, let’s assume the book value on those assets is $1,000 so there is no gain, no earnings impact and no tax impact.)
Company leadership says its shares are undervalued, so to help out shareholders it will “return the money to shareholders via a share repurchase” (note, it is not giving money to shareholders, just buying shares. $1,000 buys 100 shares. The number of shares outstanding now falls to 900. Earnings are still $1,000 (flat, no gain,) but dividing $1,000 by 900 now creates an EPS of $1.11 – a greater than 10% gain! Using the same industry multiple, the analysts now say the stock is worth $1.11 x 10 = $11.10!
Even though the company is smaller, and has weaker growth prospects, somehow this “refocusing” of the company on its “core” business and cutting extraneous noise (and growth opportunities) has led to a price increase.
Worse, the company hires a very good investment banker to manage this share repurchase. The investment banker watches stock buys and sells, and any time he sees the stock starting to soften he jumps in and buys some shares, so that momentum remains strong. As time goes by, and the repurchase program is not completed, selectively he will make large purchases on light trading days, thus adding to the stock’s price momentum.
The analysts look at these momentum indicators, now driven by the share repurchase program, and deem the momentum to be strong. “Investors love the stock” the analysts say (even though the marginal investors making the momentum strong are really company management) and start recommending to investors they should anticipate this company achieving a multiple of 11 based on earnings and stock momentum. The price now goes to $1.11 x 11 = $12.21.
Yet the underlying company is no stronger. In fact one could make the case it is weaker. But, due to the higher EPS, better multiple and higher share price the CEO and her team are rewarded with outsized multi-million dollar bonuses.
But, companies the last several years did not even have to sell assets to undertake this kind of manipulation. They could just spend cash from earnings. Earnings have been at record highs, and growing, for several years. Yet most company leaders have not reinvested those earnings in plant, equipment or even people to drive further growth. Instead they have built huge cash hoards, and then spent that cash on share buybacks – creating the EPS/Multiple expansion – and higher valuations – described above.
This has been so successful that in the last quarter untethered corporations have spent $238B on buybacks, while earning only $228B. The short-term benefits are like corporate crack, and companies are spending all the money they have on buybacks rather than reinvesting in growth.
Where does the extra money originate? Many companies have borrowed money to undertake buybacks. Corporate interest rates have been at generational (if not multi-generational) lows for several years. Interest rates were kept low by the Federal Reserve hoping to spur borrowing and reinvestment in new products, plant, etc to drive economic growth, more jobs and higher wages. The goal was to encourage companies to take on more debt, and its associated risk, in order to generate higher future revenues.
Many companies have chosen to borrow money, but rather than investing in growth projects they have bought shares. They borrow money at 2-3%, then buy shares – which can have a much higher immediate impact on valuation – and drive up executive compensation.
This has been wildly prevalent. Since the Fed started its low-interest policy it has added $2.37trillion in cash to the economy. Corporate buybacks have totaled $2.41trillion.
This is why a company can actually have a crummy business, and look ill-positioned for the future, yet have growing EPS and stock price. For example, McDonald’s has gone through rounds of store closures since 2005, sold major assets, now has more stores closing than opening, and has its largest franchisees despondent over future prospects. Yet, the stock has tripled since 2005! Leadership has greatly weakened the company, put it into a growth stall (since 2012,) and yet its value has gone up!
Microsoft has seen its “core” PC market shrink, had terrible new product launches of Vista and Windows 8, wholly failed to succeed with a successful mobile device, written off billions in failed acquisitions, and consistently lost money in its gaming division. Yet, in the last 10 years it has seen EPS grow and its share price double through the power of share buybacks from its enormous cash hoard and ability to grow debt. While it is undoubtedly true that 10 years ago Microsoft was far stronger, as a PC monopolist, than it is today – its value today is now higher.
Share buybacks can go on for several years. Especially in big companies. But they add no value to a company, and if not exceeded by re-investments in growth markets they weaken the company. Long term a company’s value will relate to its ability to grow revenues, and real profits. If a company does not have a viable, competitive business model with real revenue growth prospects, it cannot survive.
Look no further than HP, which has had massive buybacks but is today worth only what it was worth 10 years ago as it prepares to split. Or Sears Holdings which is now worth 15% of its value a decade ago. Short term manipulative actions can fool any investor, and actually artificially keep stock prices high, so make sure you understand the long-term revenue trends, and prospects, of any investment. Regardless of analyst recommendations.
by Adam Hartung | Jul 8, 2015 | Current Affairs, Defend & Extend, In the Whirlpool, Leadership, Lock-in, Web/Tech
Microsoft announced today it was going to shut down the Nokia phone unit, take a $7.6B write-off (more than the $7.2B they paid for it,) and lay off another 7,800 employees. That makes the layoffs since CEO Nadella took the reigns almost 26,000. Finding any good news in this announcement is a very difficult task.
Unfortunately, since taking over as Microsoft’s #1 leader, Mr. Nadella has been remarkably predictable. Like his peer CEOs who take on the new role, he has slashed and burned employment, shut down at least one big business, taken massive write-offs, and undertaken at least one wildly overpriced acquisition (Minecraft) that is supposed to be a game changer for the company. He apparently picked up the “Turnaround CEO Playbook” after receiving the job and set out on the big tasks!
Yet he still has not put forward a strategy that should encourage investors, employees, customers or suppliers that the company will remain relevant long-term. Amidst all these big tactical actions, it is completely unclear what the strategy is to remain a viable company as customers move, quickly and in droves, to mobile devices using competitive products.
I predicted here in this blog the week Steve Ballmer announced the acquisition of Nokia in September, 2013 that it was “a $7.2B mistake.” I was off, because in addition to all the losses and restructuring costs Microsoft endured the last 7 quarters, the write off is $7.6B. Oops.
Why was I so sure it would be a mistake? Because between 2011 and 2013 Nokia had already lost half its market share. CEO Elop, who was previously a Microsoft senior executive, had committed Nokia completely to Windows phones, and the results were already catastrophic. Changing ownership was not going to change the trajectory of Nokia sales.
Microsoft had failed to build any sort of developer community for Windows 8 mobile. Developers need people holding devices to buy their software. Nokia had less than 5% share. Why would any developer build an app for a Windows phone, when almost the entire market was iOS or Android? In fact, it was clear that developing rev 2, 3, and 4 of an app for the major platforms was far more valuable than even bothering to port an app into Windows 8.
Nokia and Windows 8 had the worst kind of tortuous whirlpool – no users, so no developers, and without new (and actually unique) software there was nothing to attract new users. Microsoft mobile simply wasn’t even in the game – and had no hope of winning. It was already clear in June, 2012 that the new Windows tablet – Surface – was being launched with a distinct lack of apps to challenge incumbents Apple and Samsung.
By January, 2013 it was also clear that Microsoft was in a huge amount of trouble. Where just a few years before there were 50 Microsoft-based machines sold for every competitive machine, by 2013 that had shifted to 2 for 1. People were not buying new PCs, but they were buying mobile devices by the shipload – literally. And there was no doubt that Windows 8 had missed the mobile market. Trying too hard to be the old Windows while trying to be something new made the product something few wanted – and certainly not a game changer.
A year ago I wrote that Microsoft has to win the war for developers, or nothing else matters. When everyone used a PC it seemed that all developers were writing applications for PCs. But the world shifted. PC developers still existed, but they were not able to grow sales. The developers making all the money were the ones writing for iOS and Android. The growth was all in mobile, and Microsoft had nothing in the game. Meanwhile, Apple and IBM were joining forces to further displace laptops with iPads in commercial/enterprise uses.
Then we heard Windows 10 would change all of that. And flocks of people wrote me that a hybrid machine, both PC and tablet, was the tool everyone wanted. Only we continue to see that the market is wildly indifferent to Windows 10 and hybrids.
Imagine you write with a fountain pen – as most people did 70 years ago. Then one day you are given a ball point pen. This is far easier to use, and accomplishes most of what you want. No, it won’t make the florid lines and majestic sweeps of a fountain pen, but wow it is a whole lot easier and a darn site cheaper. So you keep the fountain pen for some uses, but mostly start using the ball point pen.
Then the fountain pen manufacturer says “hey, I have a contraption that is a ball point pen, sort of, and a fountain pen, sort of, combined. It’s the best of all worlds.” You would likely look at it, but say “why would I want that. I have a fountain pen for when I need it. And for 90% of the stuff I write the ball point pen is great.”
That’s the problem with hybrids of anything – and the hybrid tablet is no different. The entrenched sellers of old technology always think a hybrid is a good idea. But once customers try the new thing, all they want are advancements to the new thing. (Just look at the interest in Tesla cars compared to the stagnant sales of hybrid autos.)
And we’re up to Surface 3 now. When I pointed out in January, 2013 that the markets were rapidly moving away from Microsoft I predicted Surface and Surface Pro would never be important products. Reader outcry at that time from Microsoft devotees was so great that Forbes editors called me on the carpet and told me I lacked the data to make such a bold prediction. But I stuck by my guns, we changed some language so it was less blunt, and the article ran.
Two and a half years later and we’re up to rev number Surface 3. And still, almost nobody is using the product. Less than 5% market share. Right again. It wasn’t a technology prediction, it was a market prediction. Lacking app developers, and a unique use, the competition was, and remains, simply too far out front.
Windows 10 is, unfortunately, a very expensive launch. And to get people to use it Microsoft is giving it away for free. The hope is then users will hook onto the cloud-based Office 365 and Microsoft’s Azure cloud services. But this is still trying to milk the same old cow. This approach relies on people being completely unwilling to give up using Windows and/or Office. And we see every day that millions of people are finding alternatives they like just fine, thank you very much.
Gamers hated me when I recommended Microsoft should give (for free) xBox to Nintendo. Unfortunately, I learned few gamers know much about P&Ls. They all assumed Microsoft made a fortune in gaming. But anyone who’s ever looked at Microsoft’s financial filings knows that the Entertainment Division, including xBox, has been a giant money-sucking hole. If they gave it away it would save money, and possibly help leadership figure out a strategy for profitable growth.
Unfortunately, Microsoft bought Minecraft, in effect “doubling down” on the bet. But regardless of how well anyone likes the products, Microsoft is not making money. Gaming is a bloody war where Sony and Microsoft keep battling, and keep losing billions of dollars. The odds of ever earning back the $2.5B spent on Minecraft is remote.
The greater likelihood is that as write offs continue to eat away at profits, and as markets continue evolving toward mobile products offered by competitors hurting “core” Microsoft sales, CEO Nadella will eventually have to give up on gaming and undertake another Nokia-like event.
All investors risk looking at current events to drive decision-making. When Ballmer was sacked and Nadella given the CEO job the stock jumped on euphoria. But the last 18 months have shown just how bad things are for Microsoft. It is a near monopolist in a market that is shrinking. And so far Mr. Nadella has failed to define a strategy that will make Microsoft into a company that does more than try to milk its heritage.
I said the giant retailer Sears Holdings would be a big loser the day Ed Lampert took control of the company. But hope sprung eternal, and investors jumped on the Sears bandwagon, believing a new CEO would magically improve a worn out, locked-in company. The stock went up for over 2 years. But, eventually, it became clear that Sears is irrelevant and the share price increase was unjustified. And the stock tanked.
Microsoft looks much the same. The actions we see are attempts to defend & extend a gloried history. But they don’t add up to a strategy to compete for the future. HoloLens will not be a product capable of replacing Windows plus Office revenues. If developers are attracted to it enough to start writing apps. Cortana is cool, but it is not first. And competitive products have so much greater usage that developer learning curve gains are wildly faster. These products are not game changers. They don’t solve large, unmet needs.
And employees see this. As I wrote in my last column, it is valuable to listen to employees. As the bloom fell off the rose, and Nadella started laying people off while freezing pay, employee support of him declined dramatically. And employee faith in leadership is far lower than at competitors Apple and Google.
As long as Microsoft keeps playing catch up, we should expect more layoffs, cost cutting and asset sales. And attempts at more “hail Mary” acquisitions intended to change the company. All of which will do nothing to grow customers, provide better jobs for employees, create value for investors or greater revenue opportunities for suppliers.
